Tax-Exempt Entities: New IRS Form 990 Asks Nonprofits About Corporate Governance Policies
 
February 15, 2008
 
Telly J. Meier- Washington
Kathleen Nilles - Washington

The Internal Revenue Service (IRS) released a new Form 990 on December 20, 2007. The New Form 990 will be used by nonprofit organizations that file information returns for the 2008 tax year and beyond. Much greater attention is focused on the governance policy practices of nonprofit organizations in the New Form 990. While neither the Internal Revenue Code nor IRS regulations require tax-exempt nonprofit organizations to adopt specific governance policies, the IRS has indicated that the adoption of certain policies (or lack thereof) will be used as a compliance marker. Thus, in anticipation of filing the New Form 990 in early 2009, nonprofit organizations should review and revise their corporate governance policies now in order to avoid any increased IRS scrutiny stemming from having to answer “No” to the policy questions set forth on the form.

The New Form 990 is a revised version of the re-designed draft Form 990 that the IRS released for comment in June of 2007. After reviewing almost 700 comments, the IRS revised the Draft Form 990 and released the updated version as the New Form 990. The Form 990 Re-design project was undertaken by the IRS at the urging of members of Congress (particularly Senators Charles Grassley and Max Baucus) and with the general support of the nonprofit community. Concerns continue to be raised, however, about the significant increase in the volume of information required to be furnished and disclosed to the public, and the associated burden (e.g., organizational time and expense).
The New Form 990 consolidated most of the corporate governance inquiries contained in the Draft Form 990 into a new Part VI entitled, “Governance, Management and Disclosure.” Part VI has three subsections.

• Section A (Governing Body and Management) inquires about the composition of the Governing Body and certain governance and management practices, including (i) whether the nonprofit organization contemporaneously documents meetings of its board and committees, and (ii) whether the nonprofit organization has written policies and procedures to ensure that its branches, affiliates and chapters operate consistently. A “No” answer to either of these questions is required to be explained.
• Section B (Policies) asks specifically whether the organization has five different types of corporate governance policies, including a conflict of interest policy, a whistleblower policy, a document retention and destruction policy, a process for determining compensation, and a policy or procedure requiring the organization to evaluate its participation in joint venture arrangements.
• Section C (Disclosure) inquires as to whether (and how) certain corporate documents are disclosed for public review.

The following is a brief overview of the governance policies that the IRS would like all tax-exempt organizations filing the New Form 990 to adopt. Organizations now have clear guidance on what is expected by the IRS and a window of opportunity to adopt policies and procedures that will put their corporate governance “house” in order.

Conflict of Interest Policy

Question 12a of Part VI asks the nonprofit organization whether they have a written conflict of interest policy. If the nonprofit organization answers “Yes,” there are two follow-up questions: (1) whether officers, directors or trustees and key employees are required to disclose annually interests that could give rise to conflicts, and (2) whether the organization regularly and consistently monitors and enforces the policy.

Nonprofit organizations are increasingly subject to intense public scrutiny, especially when an officer, director or other related party is perceived to benefit inappropriately. Thus, a conflict of interest policy should emphasize the nonprofit director’s duty of loyalty, which requires every director to act in the best interest of the nonprofit organization, rather than in the personal interest of the director or some other person or organization. A good conflict of interest policy should also:

• require officers, directors and staff to act solely in the interests of the nonprofit without regard for personal interests
• include written procedures for determining whether a relationship, financial interest or business affiliation results in a conflict of interest
• prescribe a certain course of action in the event a conflict is identified

In addition to helping directors and officers avoid the appearance of impropriety or an actual fiduciary breach, a well-drafted conflict of interest policy helps nonprofit organizations to safeguard their tax-exempt status, which can be jeopardized if they operate in a manner inconsistent with their charitable purposes.

Whistleblower Policy

Question 13 of Part VI asks whether the nonprofit organization has a written whistleblower policy.

Since the Enron and WorldCom scandals, nonprofit organizations have been encouraged to adopt a whistleblower policy. Whistleblower policies establish a procedure for individuals to report complaints or unethical conduct occurring at an organization without fear of retaliation. A well-drafted policy allows the organization to investigate and remedy any potential issues before a situation has unintended consequences. When adopting a whistleblower policy, nonprofits should consider the following questions:

• How broad should the policy be?
• Who is protected by the policy?
• How should complaints be reported?
• Who should resolve the complaints?
• What protection is the whistleblower afforded?

Document Retention and Destruction Policy

Question 14 of Part VI inquires as to whether the nonprofit organization has a written document retention and destruction policy.

Nonprofit organizations should adopt a written policy establishing standards for document integrity, retention and destruction. The document retention policy should also include guidelines for handling electronic files, and should cover backup procedures, archiving of documents and regular system reliability check-ups. Retention is particularly important for certain supporting documents, such as contributions, purchases, sales, payroll, grant applications and awards, sales slips, paid bills, invoices, receipts, deposit slips and canceled checks, because they provide documentation of an organization’s transactions and accounting entries. Tax returns, including employment tax records, are subject to special retention requirements.

Compensation Policy

Question 15 of Part VI asks the nonprofit organization whether the process for determining compensation of the organization’s chief executive officer, executive director, top management official, or other officers or key employees include a review and approval by independent persons, comparability data, and contemporaneous substantiation of the deliberation and decision. These are the procedures for satisfying the rebuttable presumption of reasonableness under Section 4958 of the Internal Revenue Code.

Nonprofit organizations should adopt a compensation policy designed to ensure that no more than reasonable compensation is paid for services rendered. Nonprofit organizations generally do not compensate board members for service but frequently reimburse them for board-related expenses. Nonprofit organizations almost always compensate officers and staff. A well-drafted compensation policy will ensure that the compensation is “reasonable,” which is particularly important to establish for senior officers who exercise substantial control over the organization. In determining what is reasonable, the board-delegated committee should review what persons performing similar tasks for similar organizations are receiving as compensation. Section 501(c)(3) and 501(c)(4) organizations should include the rebuttable presumption procedures referenced above and in Part VI, Question 15, of the New Form 990.

Policy on Affiliated Organizations

(Including Joint Ventures)

Question 16 of Part VI asks whether the nonprofit organization invested in, contributed assets to, or participated in a joint venture or other similar arrangement with a taxable entity during the year. If “Yes,” the nonprofit organization is asked whether it has adopted a written policy or procedure requiring the organization to evaluate its participation in joint venture arrangements under applicable federal tax law, and taken steps to safeguard the organization’s exempt status with respect to such arrangements.

A nonprofit organization may team with another organization, exempt or non-exempt, to carry out its mission. These partnerships, while valuable, carry significant risk. A joint venture may lead a nonprofit organization to stray from its charitable purpose, which can cost the organization its tax exemption. As a result, a policy should be adopted that safeguards the nonprofit organization’s tax-exempt status when partnering with other entities. The policy should make it clear that joint ventures must do the following:

• permit the tax-exempt partner to act exclusively in furtherance of its exempt purpose and only incidentally for the benefit of the for-profit partners
• allow the nonprofit organization to retain “effective control” of the venture
• provide the organization with enough authority over operations to further its charitable purposes

Operational Consistency Policy

Question 9a of Part VI inquires as to whether the nonprofit organization has any local chapters, branches, or affiliates. If the nonprofit organization answers “Yes,” it is asked in Question 9b whether it has written policies and procedures governing the activities of such chapters, affiliates, and branches to ensure their operations are consistent with those of the nonprofit organization.

The operational consistency policy should provide guidelines of operation that ensure uniformity and consistency in carrying out the nonprofit organization’s mission. The policy should incorporate frequent internal review of each affiliate’s operations and development activities.

Conclusion

By acting now to draft or update and adopt corporate governance policies, nonprofit organizations and their general counsel can avoid having to answer “No” to IRS inquiries regarding what the IRS considers to be important benchmarks of tax compliance. The window of opportunity for acting to avoid an embarrassing disclosure is tax year 2008 for the New Form 990s due to be filed in 2009.

For more information, email Kathleen M. Nilles or Telly J. Meier at kathleen.nilles@hklaw.com or telly.meier@hklaw.com, respectively, or call toll free, 1.888.688.8500.